1. How Much Down?
2. How Much a Month?
3. Can I Qualify?

Some customers ask it when they first walk in. Some customers wait until we go through the typical buyer / seller conversations and then ask. Some don't even ask. But every single person wants to know "Can I afford this house".

Being real honest, isn't that all that really matters? It doesn't really matter how nice the kitchen is if you can't afford the down payment. It doesn't matter if the energy package saves you $100 a month if you can't pay the mortgage payment each month. And it doesn't matter if you can afford it if no one will give you a loan.The problem is that about 50% of the mortgage loan officers I've dealt with in the past can't give you an accurate answer. About 80% of the builders I've meet don't know the answers. And at least 95% of the Realtors I've worked with don't have a clue on how much money you need to move in, what your monthly payment will be and if you can qualify for a loan. So the best method is for you to know before you enter your first model home. So let us reason together.

• How Much Down

Your upfront expense will consist of three items: Down payment, Prepaids, and Closing Cost. Down payment is the actual amount you are paying that goes towards the purchase price of the home. Prepaids are insurance and taxes that are paid in advance. Closing Cost are fees required by the lender (mortgage company) and title company to process all of your paperwork. Lets look at each one a little closer.

Down Payment
The lender is going to require the buyer (you) to have some money invested in the home. The percentage depends on the mortgage program that you choose. For an example we will use the Community Homebuyer Program, which at the time this book was written requires 5% down payments. Example: Sales Price of $100,000, down payment requirement of 5% (.05) would equal a down payment of $5,000. So in this example the buyer would be required to come up with $5,000 for the down payment and leave a loan balance of $95,000. The down payment requirements are usually different for each mortgage program. Each one will be discussed later in the book.

Prepaids
As mentioned earlier prepaids are taxes and insurance paid in advance. Most mortgage programs require 14 months hazard insurance paid in advance. This protects the lenders loan in the event the home was destroyed in fire, tornado, etc. No matter how good a person you are, most people would stop making mortgage payments on their home if it was destroyed. The lender wants to be sure they get back their investment. For the example we will $480.00 for one year's homeowners insurance. Your actual amount will depend on which policy and insurance company you choose.

Example:

One Years Homeowners Insurance = $480.00

$480.00 / 12 months = $40.00/mo. X 14 months = $560.00

The lender will also require approximately 3 months taxes paid in advance . The money will go into a reserve account that you will pay into each month. The lender will than pay your property taxes each year. This prevents the local tax authority from putting a tax lien on the home if you get behind. The lender does not want your home to ever be sold in a tax sale because that would wipe out the remainder of the loan they made on the home. For the example we will use a tax rate of 1.2%. Your actual rate will be set by your local tax authority.The last item that makes up prepaids is the interest you pay for the days between when you close and take possession of your home to the first day of the period covered by your first monthly payment. That really sounds confusing. Let me explain. When you are making a payment on a home it is for the previous month, unlike rent which you pay in advance. If you were to close on a home May 15th, your first house payment would not be till July 1st. Your July 1st payment would be for the month of June. So the lender charges you interest for the period from the day they loaned the money at closing to the first day covered by your first payment.

Example:

Property Tax of 1.2 % X Sales Price of $100,000 = $1,200/yr
$1,200 / 12 months = $100/mo.

$100 X 3 months = $300

Example:

Loan Amount = $95,000
Interest Rate = 9%
Closing Date is May 15th
First payment period begins on June 1st
Prepaid interest due for 16 days: May 15th - 31st
Interest per day = $23.3516 Days X $23.35 = $373.64
Prepaid Insurance = $560.00
Prepaid Taxes = $300.00
Prepaid Interest = $373.64

Total Prepaids = $1,233.64

Closing Cost
Closing Cost include everything it cost to get the loan and take ownership of the home. This includes but is not limited to attorneys fees , title insurance , the origination point , recording fees, appraisal fees, surveys, etc. These fees normally add up to 2 % - 3% of the loan amount. They vary depending on the mortgage company and title company you use. If you go to the form section of the book, look at the settlement statement to see approximately how much each line item should be. For the example we will use 2.5 % times the loan amount.

Example:

Loan amount $95,000 X 2.5 % = $2,375 Closing Cost
For our example of a $100,000 sales price with 5 % downpayment
Down payment = $5,000.00
Prepaids = $1,233.64
Closing Cost = $2,375.00

How Much Down = $8,608.64

But don't get discouraged if $8,600 looks to high. There are many ways to lower the total move in cost. As you continue on you will learn about seller contributions, gifts, lender contributions, sweat equity and special programs that can get your out of pocket cost lowered. In some cases $0 is needed to close on a new home. Keep Reading!

• How Much A Month

Now that you have some idea what it will cost to move in, you would probably like to know if you can afford to stay. There are five items that make up a monthly payment : Principle, Interest, Taxes, Insurance, and in most cases, Mortgage Insurance (PITI for short). You need to know what these items are, so let us reason together.

Principle and Interest
The priciple part of a mortgage payment is the amount that goes directly to paying down the balance of your loan. Interest is what you pay the lender for use of their money.

Example:

Loan Amount = $95,000
Interest Rate = 9%
30 year loan = 360 payments

Principle and Interest = $764.39

You can use the tables at the back of the book to figure the principle and interest or purchase a finical calculator. They are inexpensive and I highly recommend them. Now lets break that payment down to see how much went to paying back the loan and how much is interest.

Example:

Loan Amount = $95,000
Interest Rate = 9%
30 year loan = 360 payments
Principal = $51.89
Interest = $712.50

Principle and Interest = $764.39

So out of your first mortgage payment all most all of it goes to paying interest. This reverses during the years and more of your payment will go toward the balance of your loan. Later I will tell you some ways to accelerate the payoff of your loan. The good news is the amount of interest you are charged on a home is normally lower than interest on any other kind of loan. This is because a mortgage loan is one of the safest loans a lender can make. Unlike cars, boat , or items charged on your credit card, your home should go up in value over the years. The lender is in a safer position if you default on a mortgage than on a car loan.

Tax Escrow
This is an escrow account that is operated by the mortgage company to pay your property taxes each year. Every month you pay 1/12 of your estimated annual property tax to your mortgage company. They set this money aside in an escrow account, and then pay your taxes at the end of the year when they are due. For the example we will use a tax rate of 1.2%. Your actual rate will be set by your local tax authority.

Example:

Property Tax of 1.2 % X Sales Price of $100,000 = $1,200/yr

$1,200 / 12 months = $100/mo.

The reason mortgage companies require it be done this way is to prevent the local tax authority from putting a tax lien on the home if you get behind. If you couldn't pay your property tax at the end of the year your home could be sold by the local tax authority. The lender does not want your home to ever be sold in a tax sale because that would wipe out the remainder of the loan they made on the home. So the lender collects 1/12th of your property tax each month and pays the tax bill with that money. Some people don't like this but it is a good rule. The mortgage companies will normally wave this rule if you make a downpayment of 20% or more. They feel with the buyer investing this money in the home they can be trusted to pay there taxes at the end of the year and will have the necessary funds available.

Insurance
This is Homeowners Hazard Insurance and the idea is similar to the tax escrow. Each month the lender is going to collect 1/12th of the cost of your Insurance, and than pay your insurance policy at the end of the year. This is to prevent them from losing their investment if your house is ever destroyed in a fire, toronado, etc. You select the insurance policy and company you would like to use. For the example we will $480.00 for one years homeowners insurance. Your actual amount will depend on which policy and insurance company you choose.

Example:

One Years Homeowners Insurance = $480.00

$480 / 12 months = $40.00

Note : It may seem like the lender is trying to be your mother, telling you that you can't save money and pay your own property taxes and insurance, that they need to do it for you. But even if you can there are a lot of people out there who can't. I believe it is best that they do it this way.

Mortgage Insurance
You shouldn't have to pay this, but you do. Unless you pay a 20% downpayment. This insurance is for the lender , but you pay it. It covers part of the lenders losses should you default on the loan. It is not right but most mortgage programs require it. The price of Mortgage Insurance depends on the mortgage program. For our example we will use $60.00 a month.

Example:

For our example of a $95,000 loan with 9% interest for 30 years
Principle and Intrest = $764.39
Homeowners Insurance Escrow = $40.00
Tax escrow = $100.00
Mortgage Insurance = $60.00

How Much A Month = $964.39

Once again, don't panic if this seems out of your reach. We will discuss ways to lower your monthly payments as we go through the different loan programs. These examples were to show you how move in cost and monthly payment are calculated, not what the best possible cases are.

• Can I Qualify

There are really four items to look at to see if you qualify. Your ratios, to see if you can make the payments. Your bank account , to see if you have the money. Your job history to see if your stable, and your credit history to see how you pay back loans. Lets look at each one of these individually.

Ratios
The lender is going to want to know if you can pay your mortgage payment every month. They use what is called a front ratio to determine that ability. They take your monthly gross salary multiplied times the front ratio to tell what your maximum mortgage loan payment can be. For our examples we will use the FHA mortgage programs ratios. The FHA front ratio is 29%. The ratios will vary according to which mortgage program you choose. For this exercise, our example couple will have a combined gross annual salary of $50,000 a year.

Example:

Gross Annual Salary = $50,000
Gross Monthly Salary ( $50,000 / 12mos ) = $4,166.67

Front Ratio .29 X $4,166.67 = $1,208.33

Under the FHA guidelines, the maximum mortgage this couple qualifies for is $1,208.33 on the front ratio 29% of their gross monthly salary. But the lender is also required to check how much other debt the couple has to pay each month. For this, each mortgage program has a back ratio. The back ratio limits how much long term debt and maximum mortgage payment allowed. FHA's back ratio is 41%.

Example:

Gross Monthly Salary = $4,166.67

Back Ratio .41 X $4,166.67 = $1,708.33

This couples total monthly long term debt and mortgage payment cannot exceed $1,708.33. Long term debt includes car payments, student loans, bank loans, credit cards, etc. that you will be paying on for more than six months. If a debt will be paid off in less than six months it normally will not count.

Example:

Auto : Monthly Payment = $250, Payments Remaining = 26
Credit cards : Monthly Payment = $100, Payments Remaining = 12
Student : Monthly Payment = $80, Payments Remaining = 60
Bank : Monthly Payment = $200, Payments Remaining = 4

Long Term Debt: Monthly Payment = $430

In this example, the bank loan did not count as long term debt because it was going to be paid off in a short period. To calculate the maximum mortgage payment that the couple qualifies for under the back ratio, the long term debt is subtracted from the back ratio calculation.

Example:

Back Ratio Calcuation = $1,708.33
Long term debt - $430.00

Back Ratio Maximum Payment = $1,278.33

On this example the back ratio maximum payment is higher than the front ratio maximum payment. The maximum payment the couple qualifies for is the lower of the two ratios, which in this case is the front ratio.

Example:

Front Ratio Maximum Payment = $1,208.33
Back Ratio Maximum Payment = $1,278.33

Maximum Mortgage Payment = $1,208.33

If the bank loan had 12 payments remaining the long term debt would have been $200 higher, and changed the maximum mortgage payment.

Example:

Auto : Monthly Payment = $250, Payments Remaining = 26
Credit cards : Monthly Payment = $100, Payments Remaining = 12
Student : Monthly Payment = $80, Payments Remaining = 60
Bank : Monthly Payment = $200, Payments Remaining = 12
Long Term Debt: Monthly Payment = $630
Back Ratio Calcuation = $1,708.33
Long term debt - $630.00
Back Ratio Maximum Payment = $1,078.33
Front Ratio Maximum Payment = $1,208.33
Back Ratio Maximum Payment = $1,078.33

Maximum Mortgage Payment = $1,078.33

The back ratio maximum payment was the lower of the two ratios. The maximum mortgage payment in any mortgage program is always the lower of the two ratios. You cannot qualify for more than the lower payment. As you have probably already guessed, the back ratio is normally the one that holds down how much home someone qualifies for. Everyone seems to have a lot of debt. The best thing you can do is to try to reduce the debt as quickly as possible. But we will discuss other avenues later.

Bank Statements
The lender normally request to see your last three bank statements to be sure you have money to close on the home. You are not required to have all the money in your account at the time you apply for the loan. The lender will want to see how you plan on coming up with the rest of the money and will want documentation on where all the money came from. Do not ever borrow money for your downpayment, prepaids, and closing cost unless your lender knows about it and approved it in advance. You do not want to risk loan fraud. No home is worth going to prison. To loan someone that much money, the lender will want to see a minimum investment from the buyer according to the guidelines of the mortgage program for which they are applying.Note : Don't ever accept money from the builder of a new home or the seller of a used home unless the lender has approved it in advance.

Employment History
The lender will mail a " verification of employment " to the place where you work. This ask your employer how much you make , how long have you been employed, and what is the outlook on your continued employment. Most lender would prefer to see that the buyer has been at the same job for at least two years. There are number of exceptions. If you have recently gotten out of school, less than two years ago, that will not count against you. If you have recently been laid off but have now found employment the lender will normally count your prevous job time. When someone changes employers but stays in the same line of work, the prevous employment will be counted.

Credit History
Before a mortgage company makes a loan, they are going to look at the buyers credit history to see how well they paid everyone else they borrowed money from. They don't want to make a loan to someone who doesn't pay people back. They will pull up a credit file from all three credit agencies to see what each one has on their record. When they pull up your credit report they will report back to you any negative items that appear. Don't panic if you have a few items. You can still get a loan. There is a whole chapter in the book about the worst of bad credit. If you have never established credit, the mortgage company can build a credit file out of other items. If you are currently renting they can use your rental history. A phone that is in your name or gas, electric or water bill that you pay. These are all forms of credit.

If you have some late payments on your credit report the lender will want letters from you explaining why you were late. They look most favorable on buyers who were late due to medical problems or loss of employment. Underwriters understand that if you have a medical problem and everything is not covered by your insurance company, you will probably not be able to handle all the bills in a timely manner. They also understand that if you lost your job it's logical that all your bills did not remain current. If you have a bankrurtcy that has been discharged over 18 months, and have started to reestablish credit you can qualify for a loan. All of these items are discussed in greater detail in the bad credit chapter.

If you have paid attention to what you have read, you have a better understanding than most people in the Real Estate Industry on what it takes to purchase a home.